CONTRACT RENEGOTIATION, MECHANISM DESIGN, AND THE LIQUIDATED DAMAGES RULE

The common law practice of refusing to enforce contractual penalties h as long mystified law and economics scholars. After critiquing the pre vailing law and economics analyses of the common law rule, Eric L. Tal ley reevaluates the penalty doctrine using the game theoretic techniqu e of mechanism design, which facilitates the analysis of multiparty ba rgaining situations under various assumptions. Using this technique to model the allocational consequences of various enforcement regimes th at courts might adopt with respect to stipulated damages clauses, Mr. Talley finds that penalty nonenforcement can increase economic efficie ncy by discouraging strategic behavior by the parties, thereby inducin g more efficient contract renegotiation.